Will Federal Reserve regional banks not be able to pay interest on reserves?

Ask an Economist

Is it possible that Federal Reserve Regional Banks (MPLS, KC, et.) can not or will not be able to pay IORB (interest on reserve balances ) held by member banks in their respective regions? That is, the interest received on the Regional Bank's longer duration bond portfolios may not be high enough to pay member banks of their reserve balances. In other words, did the FRB itself make the same duration mismatch mistake as did the private banks that were recently shut down and sold? If this is true, won't long-term bond/loan rates start to fall even more than they did last week -- regardless of what the FED says about future rate hikes?


No, it's not possible; that is, the Federal Reserve can always pay IORB.  The reason is simple: unlike an ordinary bank, the Fed's liabilities are in units (dollars) that it creates.  Put differently, unlike a private business, the Fed does not need to pay its expenses by drawing on current revenues, retained earnings, or credit.

The Fed typically earns more on the assets it holds than it pays on its liabilities, primarily because it pays no interest on some of its liabilities, like the $2.3 trillion of currency outstanding.  The Fed then pays its expenses from the surplus and remits the rest to the U.S. Treasury.  See https://www.federalreserve.gov/newsevents/pressreleases/other20230113a.htm for a summary of the Fed's remittances over the past decade.

The aforementioned press release also points out that the Fed's interest income is currently less than its interest expense.  How does the Fed deal with that?  Under the Fed's accounting rules, in such a situation the Fed accumulates a "deferred asset" equal to its cumulative losses.  The deferred asset is the amount of net earnings the Reserve Banks will need to realize in the future before their remittances to the Treasury resume.  Data on the current size of the deferred asset is available in Table 6 of the Fed's H.4.1 release (https://www.federalreserve.gov/releases/h41/) under the line item, "Earnings remittances to the U.S. Treasury".

A deferred asset, however, has no implications for the Federal Reserve's conduct of monetary policy.  The Fed's congressional mandate is neither to make profits nor to avoid losses; rather, it seeks to achieve maximum employment and stable prices.  In line with its commitment to return inflation to its 2-percent objective, the Fed has been increasing the target range for the federal funds rate since March 2022. While the rising interest rates have ancillary effects for the Federal Reserve's income (which turned negative over the past year) and remittances (which have ceased for a time), the Fed's net income will eventually turn positive (recall that a significant share of the Fed's liabilities do not pay interest) and the deferred asset will be paid down.  As such, these ancillary effects do not impair the Fed's ability to conduct monetary policy (or to fulfill any of its other responsibilities).

Answered by:
Last updated on March 31, 2023